As the U.S. economy emerges from the Great Recession, the freight rail industry’s growth “is in high gear,” according to Dahlman Rose & Co. Director-Equity Research and Railway Age Contributing Editor Jason Siedl (pictured). “Recent Class I commentaries describe a robust first quarter and paint a bright 2010 industry picture.” Traffic has grown an average of 7% for the “Big Seven” (BNSF, UP, CSX, NS, CN, CP, KCS) since the beginning of the year.
In terms of continued pricing strength, “There is leverage this time around,” says Siedl. “We have identified three important adjustments the railroads have made that weaken the view that they will be unable to maintain a low cost structure as freight volumes return. First, railroads now have a better strategic approach to cost cutting. Instead of firing staff as they did in the previous recovery, the railroads shifted to furloughing employees, which should enable the companies to re-staff in the span of a few weeks as opposed to months.
“Second, the railroads have spent $40 billion on infrastructure upgrades, maintenance, and new projects, significantly improvingtheir networks to avoid future recovery-related congestion,” Siedl says.
“Third, unlike the previous recovery, the railroads have access to locomotives and cars in storage, which they can utilize at lower incremental cost as traffic improves,” says Siedl.
“For these reasons, we believe the rail industry will manage this recoverybetter than the previous one. While better-than-expected earnings are likely to boost rail stock prices, the increased free cash flows generated in an improving freight market are likely to encourage management to increase dividends and share repurchases as they have done in the past,” says Siedl. “We believe thesetwo options are the most likely as many railroads have record amounts of cashon their balance sheets and the likelihood of a major acquisition in the current political environment is low.”